Business Ethics is Shaky Here – What About in China?

Where I’m Coming From

I’m an American and am disgusted and embarrassed by all the corruption recently uncovered in US corporations. At the same time, being of Chinese ethnicity, I’ve been disturbed by Chinese in China blatantly violating agreements and business law such as mass copying of copyrighted material.

So I need to first say this article is not about philosophical or moral issues. My blog is to provide guidance to help US firms get business done in China more easily and efficiently. More profound thinkers can figure out the mysteries of ethics in this world. I’m digging into the Chinese mind to see how it views our notion of ethics and hopefully come up with intelligent ways to deal with this issue when conducting business in China. I’m analyzing the lack of “ethics” and “integrity” in China and suggesting ways to cope with it.

The Explanation Starts Here

Chinese live in an environment we cannot imagine. For Americans, the idea that your spouse or parents could suddenly disappear in the middle of the night for two years cannot be real – either a nightmare or something that happens in some uncivilized country.

But that happened to a Chinese biochemical professor who stayed at our house at Stanford during his exchange studies, except it was he who was taken away during the night. For TWO YEARS he was locked up in a jail without knowing why he was there while his wife and son continued living their daily life with no explanation of what happened. Finally, he was told he had made a derogatory remark about Mao Zedong’s wife when she spoke at his college campus. One of his friends had reported on him. After two years of jail without explanation he was abruptly released on the condition he would stand up on a public stage for a day and loudly confess his stupidity. Yes, that was 20 years ago, but there are tens of thousands of such memories still in the heads of Chinese citizens today.

Now fast forward for a reality check in China today. Amazingly, not a lot has changed in terms of “Big Brother” situations: Sudden shutdown of your business, change of rules and regulations without warning, sudden disappearance of institutions, media outlets, sources of goods and services, people, or massive removal of jobs or relocations with almost no explanations or warnings. This is happening now!

Just last week, some lawyers who are known to represent Government dissenters in China suddenly disappeared! No explanations and no official statements. Poof! They’re gone. No official news. Only through pieces of evidence circulated through the Internet was this known.

What does this have to do with ethics?

The psychologist Abraham Maslow in his famous 1943 paper A Theory of Human Motivation, explained how humans operate under a hierarchy of needs. We first take care of our most basic needs, like bodily safety and hunger. As each lower level is taken care of, we can progress to the next higher level until at the top, after we have satisfied our personal needs for recognition and/or fortune, we move into altruistic endeavors to help others or to enhance society in some way. Maslow showed how we cannot jump up levels of priority until lower needs are satisfied. The homeless man who is hungry cannot worry about some higher issue like campaigning to stop pollution. Or the ethics of stealing food from the back of a restaurant.

Most Americans in the business world are not at the low levels of Maslow’s hierarchy of needs. They are not regularly worried about their basic safety or security, such as whether or not they have food on the table, or if their home might be taken away, or their spouse disappearing, or their business suddenly shut down. Generally, we’ve been at a much more comfortable level for many generations. We have a democratic government that gives the people a lot of protection and a system of law and order that is much more predictable and stable than in China.

Imagine Growing up in China

In contrast, generations in China have existed at the lowest levels of Maslow’s hierarchy. A young man there would know about horrors inflicted on his parents, grandparents, friends’ relatives, etc. A sense of survival is inborn and nurtured within him. He grew up learning hard lessons we would consider outlandish. I suppose it is not unlike growing up in a ghetto in the US where you join a gang and together you fight for survival.

The overall theme in China is “I gotta survive today. Tomorrow might be a whole different thing! Get it now – I may not have a chance tomorrow! Rules and laws and agreements? What do they mean a few days from now? They come and go, changing whenever – and I have no control over it.”

If you grew up having seen survival only by the smartest, shrewdest, toughest people, you would certainly learn everything you could about how these survivors operate. If you don’t, you will not survive!

Integrity was not in her vocabulary

Jenny spent half her lifetime in China, coming to the US at the age of 20, then progressed through the highest levels of academia and the US corporate world. She told me a shocker about herself: She did not know what the world “Integrity” meant when she arrived in the US! Further, you can’t just look up the meaning of such a word because you still wouldn’t get it unless you had the experience to understand it. It’s like looking up the word “love” – would you get it without appropriate experience? Jenny had to learn the meaning of the word gradually as she watched people operate with integrity.

Growing up in China with constant concern for survival puts a different light on basic behavior. A lot we take for granted does not apply. How can you be concerned with Integrity and operate on a high ethical level if any day you could be suddenly locked up in a jail without explanation?

George, a Chinese entrepreneur living in California, came back from China having secured the “exclusive US marketing rights” for a biometric lock. He and the CEO had developed a close relationship and they agreed to grow a distribution company together in North America. As George began promoting the lock across the country, he learned the same lock was suddenly available from a small vendor in New York who also claimed he had the “exclusive rights.” When George confronted the CEO about the breach in their agreement, the answer was: “He brought cash to the door! You don’t expect me to turn down cash do you?! Besides, he is just a one-man company; he won’t be much competition for you.” When George asked about the “exclusivity” agreement, it turned out the CEO did not even know what the word meant!

(BTW, contracts written by US companies’ lawyers are a joke. They are undecipherable by even US business executives, so what are they thinking when they ask Chinese to sign them? Don’t these lawyers realize their stupid language just gives others an excuse for misunderstandings later?)

The business people in China have not had 10 years in the US as Jenny had to learn what words like integrity and ethics mean. Even if they learned the words, the environment in China does not allow these words to be fully functional. Maslow would say: They can’t operate at this level if they are still concerned about going hungry at any moment!

What to Do

How to do business in China without getting burned? The answer starts by recognizing there are no simple rules. I cannot give you 10 steps to dealing with ethics in China.

Think this way: How would you deal with a homeless, destitute person if you needed his help in doing some work and he barely speaks English?

You give simple instructions

You monitor his work

You keep your eyes on him

You can consider him a cheap resource to get your task done, but also keep in mind:

He is a fellow human being who is trying to survive the best he knows how

He is living from day to day and does not have the luxury to plan ahead in his life

He is not able to communicate with you at your level of English, your social status or your position on Maslow’s hierarchy of needs

Having given you a general orientation, let me give you the suggested attitude toward a Chinese Manufacturer:

I’m using Chinese factories because they are a very cheap resource compared to most alternatives

However, I know there are some extra procedures and costs involved in using this resource

They also know they are a cheap resource for me, but they actually don’t want to be. They are forced by competition to work at minimal margins

They are trying every way they can, every day, to make more profits, and they know their competitors are doing the same – they are all trying to survive another day. I know they will cut corners, cut quality, extend delivery, inflate fees, any way they can; they operate under a short term, survival mode

In negotiating deals, I engage practical, savvy lawyers who are not creating contracts that sound good to me, but create simple, enforceable contracts that make sense in China.(I want contracts that maximize the probability of good performance, not US type contracts that only lawyers can interpret and protect you in case you go to court – going to court against Chinese entities is a whole different subject but for now let me say it is a fruitless pursuit! So why create contracts that are ineffective?)

I will establish the best communication channel possible, the ideal priorities being: blood relatives, personal acquaintances, schoolmates, long term business associates, reputable firms, etc.

I will set up methods of checking quality and progress to the maximum extent practical, starting with continuous process checks, daily monitors, batch/lot checks, random tests, etc.

If possible, I would set up quality and progress checks on sub-vendors and all critical suppliers

I recognize some factories produce well-designed products from the US at virtually break even margins, then make their profits selling unofficial copies of the same thing to 3rd-world markets at a premium price. If I am not interested in selling to those markets, maybe I turn a blind eye to their side operation so I can continue getting my low prices.

Sooner or later I may catch my manufacturer at some shady act. I can sever relationship with them as evil entities and go through the enormous hassle of finding another supplier who might be just as evil, or I can treat them as naughty children, make a big, threatening fuss, get them to correct their behavior and continue watching them. I know the latter approach will make more sense over the long term.

Today I’m going to tell you about a game that is played by many Chinese manufacturers. It’s a game they might win at and you as the customer can only play to avoid losing. To understand the game better, let me take you into the head of a factory manager so you can see it from his perspective. Close your eyes for a moment and imagine owning a factory in China.

You live in China. All around you are other factories making mostly foreign goods. You have some existing customers but you’re wary of losing them either because they no longer need the products or they go elsewhere for manufacturing. So you need to keep hustling for business. You have contacts in the US and elsewhere who bring you business. Your concerns are to keep your factory busy, retain your employees and make as much profit as you can. After years of suppression in China, there is now the unleashed freedom to be a capitalist, to run your own show and ultimately to be a millionaire … whatever that means. But the basic game plan is simple and exciting: Grow, Make profits, Be clever, Gain, Win, Earn More, Get Bigger, Repeat.

Nothing too surprising so far. You already knew most of this. Now let’s crank it up a notch and get into operational details.

You are contacted by a new prospective customer! He wants a quote and asks about your facilities. You activate your Get The Order play book. You quote a price low enough to get the job … maybe a little lower to make sure. Reassure and impress the prospect every way you can. Need samples of your work? Make up the most beautiful, perfect samples possible. They want to visit your facilities? Set up a showcase section of your factory, with attractive workers in pristine white coats, clean machines. clean work benches, etc. You orchestrate the performance: no chit chat, steady production rate, no breaks, demonstrate efficiency. Spare nothing. This is the Get the Order operation! The visitors are impressed. They leave. You dismiss your actors and tell them you’ll call them back for real work if you get the order.

Success! You got an initial order! Now, you set up the production line. Make many shipments to the customer’s satisfaction. The business is steady, repeating and growing. Now the Game starts.

Objective: Increase profits! Time to get clever and think of all possible ways, which in China includes many approaches we might be shocked at: Cut out some of the material, or change to a cheaper grade material. Leave out non-essential parts. Cut corners on labor. Change to a cheaper chemical that does the same thing, or almost does the same thing. Make some parts smaller. Use less glue or screws. Make parts thinner, narrower, less finished. The idea of the game: how can you improve profits without incurring complaints? When you sit around socializing with your other factory friends, it’s fun to swap stories of how clever you were and what you are getting away with.

Not all factories play this game or at least not to an extreme degree. But it is a prevalent phenomena in China nevertheless, partly due to the fact that so many zillions of items are being made and shipped that most importers in the US don’t care or do not have the means to check on quality when they receive container after container of goods. This game is prevalent enough that there is a name for it: Quality Fade.

Most importers don’t even know this game is going on. They occasionally see a defect in their product and complain. The manufacturer backs off a step in his game, corrects the “defect” and then plays on from there. Once in a while, a blatant move in the game causes headlines, like contaminated milk or toxic wall boards, but most moves in the game are small and undetected.

There is even a corollary to this game. Some manufacturers maintain integrity of the goods for their primary customers in the US or other first world market, but then create a sub-quality copy of the same product to sell to other countries and markets. That is why within China, some discriminating customers want to buy “authentic” US-brand goods actually shipped back from the US; they suspect the identical product sold in China may not be of the same quality.

Sino Management Partners, a California firm based on high level executive connections throughout China, has Partners who actually own factories in China. The Partners know that Quality Fade is rampant in China and deal with it as a normal part of manufacturing management. Depending on the type of product, they install independent Quality Control inspectors, systems of random or regular checks, loyal managers with family ties or long time relationships, and other methods. Sino Management Partners can evaluated client situations and recommend appropriate quality programs to monitor the Game. For companies who do not have their own full time staff in China, SMP could be a way to your best win…which is not to lose.

In the US, CEOs run companies to grow profits, gain market share, maximize stock value or combinations of these. In China, CEOs have some other agendas we are not familiar with.

Knowing how they operate is valuable when we are negotiating or competing with Chinese companies, or just operating within their area of influence.

To start with, it’s useful to understand the corporate environment in China. Many major enterprises in China are state-owned. CEOs of such enterprises got there by shuffling between private and public sectors – it is a politically motivated path that takes them to their positions. Understandably, such CEOs act more as politicians of the Communist Party. It’s a stark contrast from CEOs of Western corporations acting on behalf of shareholders, employees or private interests.

Where U.S. CEOs are acquainted and often socialize with others in their industry or their markets, Chinese CEOs are more allied to their political allies and to the national interests of the Communist Party.

In fact, it’s not unusual for Chinese CEOs to link their long-term strategic decisions to plans outlined in the annual National People’s Congress (China’s legislature) or to other significant political events, such as trips to China by foreign leaders. What’s more, the symbiotic relationship between the enterprise and the state makes such CEOs sympathetic to corporate social and economic goals beyond short term profits or maximizing shareholder value.

In fact, we find that chief executives in both the public and the private sector talk more about revenue growth, market leadership, and competitive advantage than about shorter-term financial objectives, such as higher earnings. The emphasis on driving top-line growth to keep factories humming and employees on payrolls often means that Chinese companies are generalists playing in several different business areas and markets.

In China’s rapidly expanding market (until just recently), Chinese CEOs rely less on rigorous analysis, market research, or a detailed understanding of customer preferences than U.S. CEOs do. Instead, many of them make decisions instinctively and respond rapidly to new industry trends and shifts.

Knowing all this, it is useful when corresponding or meeting with Chinese CEOs to put yourself into their heads and background. You might see a different way to approach them about your own agenda. Sino Management Partners are Chinese executives who have prospered in this culturally different world, are now connected to the US in various ways and are available to help US companies bridge the gap . . . and get things done.

If you are like many typical Americans meeting with Chinese executives for the first time, you could be clueless about some fundamental cultural differences.

You are happy they speak some English, so you naturally call up your well-honed social skills developed in Western cultures. Within an hour of the get-acquainted session, you have exchanged info about your professional backgrounds plus a lot more. You’ve shared info about your personal life, wife and kids, vacations, hobbies, etc. But you may not be aware of the sparse answers you get back in return. You don’t notice because your Chinese friends seem genuinely interested in what you are telling them so you go on and on. You are proud that you are developing such close personal rapport with them.

In reality, they are bored and maybe slightly annoyed with all that personal stuff. However, they are polite and humor you so you are clueless. Also, they don’t share much of their own personal information. Their wife and kids are personal topics and not loosely shared with business associates, especially new ones. They look at the pictures of your kids politely but do not show you any of their own. One exception when they might bring up their kids is if they are trying to move them into a US school and they think you might have some guidance on this subject.

At their business meetings, Chinese executives are accustomed to chatting about hobbies and prominent places visited for business. Therefore, they would be comfortable if you talked about these subjects. Be aware, however, travel destinations discussed are not family vacation destinations but locations of important business gatherings. An analogy in the US would be conversation starting with: “Have you ever attended conferences out in Hilton Head?” Or, “I really dread those trade shows in Las Vegas – it’s such a zoo!”

Certain hobbies and sports are good topics to bring up as you may find a common bond, such as golf, poker, chess or whatever. Note that these are hobbies and avocations that do not bring your family into the picture. Don’t talk about how you and your family went camping and hiking in Yosemite since they are not ready to share info about their own family vacations.

Chit chatting about the right topics, along with the business talk directly related to your meeting, will help start building a good relationship. Be advised, however, Americans talk at their normal Type A speed, not sensing the other side is barely comprehending a fraction of the words. The American may feel the Chinese is a somewhat quiet, introverted listener when in reality he is just shy about speaking English at all, let alone at the ferocious speed of the American.

Another difference in culture: Americans cannot tolerate silence in meetings; someone will always jump in to fill the space – check it out at any US meeting. For the Chinese and Asian in general, there can be periods of silence and contemplation during a meeting. The group allows individuals to quietly digest and think about the last statements; there is no urgency to fill the silence. Americans often cannot handle their 20 or 30 seconds of silence and feel compelled to jump in with a disrupting comment.

Stay on topic, speak slowly, tolerate silence and give others a chance to I talk – very simple rules to a successful start of a relationship. And I say Start, because one meeting is not enough.

In fact, the objective of the first meeting or two, or three, is not to close a deal, or is it even a preliminary step to doing a deal. Despite the business talk, the objective is just to feel each other out to see if there can be a personal bond. Without a meaningful bond, there can be no business deal worth anything. That leads into another Blog on when and how deals are closed.

There are two major forms of incorporating your business enterprise in the People’s Republic of China. They are:

Wholly Foreign Enterprise(WFOE or WOFE)

Joint Venture(JV), which can be established in a variety of ways.

The Chinese government prefers the enterprise be established as a Joint Venture with a local Chinese partner. Rules, regulations and access to the domestic market clearly favor this method.

Wholly Owned Foreign Enterprises (WOFE)

A WOFE is an enterprise in China which is 100% owned by a foreign company or companies. Establishment as a WOFE allows the foreign firm to retain complete control and direction of the operation. It also tends to maximize return as a second party investor is not involved. But, a WOFE can be more difficult at startup as the foreign firm may have no expertise in operating in China and little knowledge of the local area.

WOFEs are generally established as manufacturing or assembly operation for the purposes of export. WOFEs in China enjoy the benefit of low cost labor. A WOFE is not allowed to sell it’s products into the Domestic market. WOFEs that sell into the domestic market use creative importation methods or export and re-import. Under either of these methods significant additional costs are incurred either as payments to a third party or in sizable duty rates.

WOFEs are often but not always, located in a Special Economic Zone(SEZ) where they can take advantage of special tax rates, improved infrastructure, and a variety of local suppliers and services which have grown in and around the zone in support of the SEZ.

Joint Venture(JV)

Joint Ventures are businesses where a foreign firm takes on a local Chinese partner. The ownership usually is 51%-49% with the foreign firm owning the majority. This is no hard and fast rule and various different proportions can be established depending upon the desires of the two parties.

Foreign companies often enter into JVs for a number of reasons. The most common reason is to gain access to the domestic market. Without forming a JV, foreign firms find it all but impossible to gain market access. A Chinese national has, by nature, the rights to sell domestically and without incurring duties or other charges. As long as the business is profitable and sales in China are incremental, JVs can be an excellent choice. Certainly, when faced with the option of no access to the domestic market, it becomes the only choice.

A second major reason for entering into a JV is to utilize the knowledge and expertise of the local partner in doing business in China and the local area. This is especially true if it is the first endeavor into China for the foreign company. The local partner can be extremely valuable in expediting the startup of the business, gaining government approvals, lining up local services and and suppliers or domestic distribution channels. They can also help to teach the foreign nationals how to do business in China, covering everything from rules and regulations to personal issues such as how to obtain expat housing and other needs.

The disadvantage to a JV is that another partner shares in the profits of the business. If this is incremental business, then it can be good for both parties. If the business is strictly export, one must question why enter into a JV and share the profits as low cost labor can be obtained in any one of a number of countries in Asia or even Latin America. (Do not forget availability of infrastructure in this equation) Along with the sharing of profits, however, comes the sharing of the investment risk as the local partner contributes funds or assets into the enterprise. Sometimes the contract assures the local partner a return on investment, mitigating business risk to him.

Shapes of JVs

Joint Ventures can take a variety of shapes in term of ownership, contributions, participation and involvement of the partners.They can be 50-50 or 90-10. The local partner may be asked to be participative in running the day to day operations or he may be a silent partner who was acquired by the foreign firm simply to gain domestic market access. In some cases, the partner may be provided guaranteed return on investment regardless of the profitability of the JV. This allows the foreign firm more control over the direction and investment options of the JV.

The two partners will enter extensive negotiations prior to business startup to work out the details of the JV. Successful conclusion of the negotiations results in a workable JV which benefits he needs and wants of both parties.

China is captivating the business world. Every day, more companies from all over the world set up businesses in China. Some come with the hope of capitalizing on the country’s low-cost labor and edging out the competition in cutthroat markets. Others are attracted by the vast profit potential of selling into China.

Setting up a company in China is a complex task that can be time-consuming and expensive. The initial phase is much easier for companies that research the steps, make good contacts and prepare for setbacks. The following are some of the issues that must be taken into consideration when planning to set up a business in China.

Calculating costs

When most people think about China, the first adjective that might come to mind is “cheap.” However, it can be surprisingly expensive to set up a presence in China, especially for companies that are not flush.

— Manager compensation package: If your company is like many others, you are going to hire an American to manage your interests.

In almost all cases, the compensation package for overseas employees includes a base salary, housing, travel and school allowances, international medical coverage and moving expenses, both at the beginning and the end of the contract.

In addition, salaries are often higher and perks such as a car and driver, a personal assistant, and rest and recreation breaks are used to entice employees.

— Space, furnishings and equipment: The next big startup expense is office or factory space, and equipment and furnishing purchases. Rental fees vary by size, location and amenities available. Equipment can be bought in China or imported from the United States. Importing can be expensive due to taxes.

— Local staff salary and benefits: English-speaking employees command much higher salaries than those who only speak Chinese, and foreign companies have to pay for costly social benefits required by local labor laws. Companies can expect to shell out almost as much money in employee benefits as in salaries.

Selecting a general manager

The next step is to select a general manager to run your business in China. Even under normal circumstances, finding a perfect fit is difficult. Add to the mix a location thousands of miles away and the hiring process becomes much more complex.

Not only does your company have to find a qualified person for the job, but the person must be emotionally limber and able to handle the day-to-day grind of doing business in the radically different Chinese culture.

Hiring local staff

In some ways, a bilingual office manager cum administrative assistant is the most important person you will hire. Bilingual employees can help your company achieve complicated tasks such as getting a business license, opening bank accounts and finding office space. A major part of an office manager’s job will be to translate for the general manager. It is crucial that he or she is someone who can be trusted. Translators have been known to not pass all information to a general manager if they feel it would disadvantage them.

Forming partnerships. Beware when forming partnerships. Many foreign companies have gone into joint venture arrangements only to find out too late that the partner company has misrepresented itself.

Find a translator and ally. A good translator puts an effort into placing your words in a culturally appropriate context, not just passing along what you say.

Practice patience. The Chinese like to get to know who they are dealing with before jumping into business discussions. Seemingly fruitless meetings are their way of building a relationship and establishing trust with you and your company.

Remember, negotiations are never over. You may fly your president across the ocean, sign the deal, shake hands and think it is all done, only to find out the next day they no longer agree.